How to trade this once-in-a-lifetime market volatility

By Cody Willard

“Wish I understood this. I’d be rich” is what http://twitter.com/jeremyross wrote as I was laying out my trading strategies in real-time during yesterday’s market crash.

He’d written that to me at http://twitter.com/codywillard, quoting my earlier tweet of “Were I a trader, I’d be covering some shorts and would buy a batch of calls every 100 points down starting right now at 10450.”

Unfortunately, understanding what I was talking about there doesn’t exactly translate into being rich, but it will help you understand how one guy who used to run money and has done tens of thousands of trades over the years would have handled yesterday’s meltdown in real-time. Thank twitter for that real-time broadcasting capability. Quite a killer app, really. But I digress. Let’s walk through my tweets from the crash and I’ll explain what each and every one meant.

When the market started crashing at about 2:30 yesterday, I was sitting at my desk watching Fox Business, looking at the cascading red lights on my monitor and reading an article on line. My gut started turning when the market went from down 300 to down 400 in a blink of an eye. Sensing that there might be a quick opportunity coming the way of what I used to call market “dislocation”, I pulled up my http://twitter.com/codywillard account and at 2:35 I wrote what Jeremy quoted:

“Were I a trader, I’d be covering some shorts and would buy a batch of calls every 100 points down starting right now at 10450.”

Here’s what that meant — I’m not a trader any more, I quit all trading when I started this TV anchoring job…but when I was a trader I’d pretty much always have both long positions (I’d own some stocks) and short positions (I’d be betting against other stocks) in order to try to keep my funds somewhat “hedged”. So when I wrote that I’d start covering some of my shorts that simply meant that I’d start to close out some of the positions in which I was betting against the stocks as the markets started to crash and I could lock in some nice profits on those shorts.

Likewise, as the DJIA was sitting at 10450 at the time I was posting that, I’d also be buying scaling into some calls, which are options that will pay off big if the markets/stocks go up. “Scaling” means I’d buy probably about 1/5 of however much I was hoping to eventually buy and then I’d put in limit orders below the current prices in case the markets did keep crashing and I’d get the chance to buy more calls at even lower prices. Then I wrote:

“Butterflies on 700 pt drop, but don’t lose cool. If you were wanting to buy start scaling. If you weren’t gonna sell yday, don’t sell today.”

That simply meant, I know you gotta be feeling crazy butterflies in your gut as you’re buying call options when the markets down 700 points on the day. But you can’t lose your nerve at that point — it’s the difference between winning big and missing the pitch entirely. Again, doing it in “scales” helps to cost-average you down and keeps some powder dry as the markets kept crashing.

“Wow, okay, now you can catch your breath. And if you scaled into calls starting at 10450 all the way down YOU ARE NOW UP HUGE!”

That was about half an hour later, as the markets had finished their final crash of 1000 points on the day but had subsquently rallied right back to the 10450 level on the DJIA where you’d started buying your calls. If you had used the scaling method, you’d have bought the vast majority of your calls when the markets were several percentage points lower just a few minutes before, and you were now up huge on those call options. Catch the breath and re-evaluate what to do after that crazy, historic move down and back up in a twenty minute span.

As we moved into the close and the DJIA was back above 10500, I tweeted:

“Sell half your calls and go home and throw a party for your girlfriend. Back at it again tomorrow! Pls spread the word http://bit.ly/RevInv.”

That meant that were I trading and had I just nailed that once-in-a-lifetime intraday crash and rally we just lived through, I’d sell half the calls I’d just bought for double or triple what I’d just paid for them. And I’d go home for the night, be distracted with real life and then come back and figure out what to do the next day.

Market volatility begets market volatility. Expect more wild swings and keep your cool as you wait for the next good pitch. Patience!

That one explains itself, no? Wait for the next good pitch!

And yes, please check out and spread the word about my weekly investment newsletter published with Marketwatch.com, available at http://marketwatch.com/cody.PS. As I also tweeted yesterday….”Oh, now I wish I were a trader again… I’d be having a huge day…instead, all I got is a tweet-trail to prove I nailed the crash! Sigh.”

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About The Cody Word

Cody Willard writes the Revolution Investing investment newsletter for MarketWatch and posts the trades from his personal account at TradingWithCody.com He is the founder of WallStreetAll-Stars.com and the principal of CL Willard Capital. Cody serves as an adjunct professor at Seton Hall University and is on the University of New Mexico Alumni Board. He was an anchor on the Fox Business Network, where he was the co-host of the long-time #1-rated show on the network, Fox Business Happy Hour. Cody, a former hedge fund manager, and his stock picks and economic outlooks have been featured on NBC’s The Tonight Show with Jay Leno, ABC’s 20/20, CBS Evening News, CNBC’s SquawkBox, Jon Stewart’s The Daily Show, as well as in the Financial Times, Wall Street Journal, New York Times, and many other outlets.